Venerable telecom giant AT&T (T -1.15%) has been a favorite among income investors for years thanks to its high-yield dividend. But the company is undergoing a multiyear transformation, which includes an impending dividend cut.
The dividend reduction is necessary. AT&T became mired in massive debt when it made acquisitions to create an entertainment empire in the years before the pandemic. These actions put the company on a dangerous financial path at a time when it faced substantial capital expenditures to implement its 5G network.
When John Stankey took over as CEO in 2020, he took steps to restore AT&T's financial health, which included cutting the dividend and unwinding the company's media acquisitions. Before deciding to invest in AT&T, it's best to understand how these changes offer both wins and downsides for investors.
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The pros of investing in AT&T
AT&T's renewed focus on its telecom roots is a win for investors. The company's telecommunications business is on fire in spite of a highly competitive U.S. telecom market.
In its 2021 full-year results, AT&T's postpaid phone subscribers, the industry's most valuable customers, rose to nearly 3.2 million net adds. That's higher than the previous 10 years combined.
AT&T's communications segment, which encompasses its mobile phone and wireline businesses, saw fourth-quarter revenue rise to $30.2 billion, up 2.4% year over year, the fifth consecutive quarter of year-over-year increases. The division's 2021 full-year revenue came in at $114.7 billion compared to the prior year's $110 billion, a 4.3% increase.
Strong equipment sales contributed to AT&T's revenue growth. Equipment revenue was up an impressive 6.2% year over year to $6.5 billion in the fourth quarter, the highest level in years as customers upgraded to pricier 5G-enabled devices. Equipment sales should continue to grow since many older devices cannot use the faster 5G network.
AT&T's WarnerMedia entertainment division, which includes streaming service HBO Max, is also doing well with Q4 revenue up 15.4% year over year. WarnerMedia will merge with cable company Discovery some time in the second quarter, and investors in AT&T at the time of the spinoff will receive an estimated 0.24 shares of the new company. This gives investors equity in a successful entertainment company.
AT&T's downsides
Despite AT&T's successes, the stock remains well below its 52-week high of $33.88, trading around $24 per share at the time of this writing. A key reason for the stock's decline is the dividend cut.
On Feb. 1, AT&T announced its annual dividend per share would be cut nearly in half from $2.08 to $1.11. The dividend reduction will occur after the WarnerMedia spinoff.
But the dividend cut isn't the only disappointment for investors. AT&T's turnaround efforts will take a while, extending well beyond the WarnerMedia spinoff.
John Stankey stated AT&T is currently in the "middle innings" of its transformation as the company works to get its debt under control while managing the capital expenditures needed for its 5G network. This is no small task.
To acquire additional spectrum to strengthen its 5G network, AT&T spent $23.4 billion in February last year, and another $9 billion this year. These types of expenditures present a challenge to AT&T's attempts to get its debt under control.
To invest or not to invest in AT&T
Although challenges exist, the elements are there for AT&T to succeed over the long run. The company's 2021 performance in its communications segment proves the company can deliver in the face of a competitive marketplace.
Its actions to reduce debt extend beyond a dividend cut and the WarnerMedia spinoff, which will pass WarnerMedia's debt on to the new company. AT&T also embarked on cost-cutting across the organization. The company reduced costs by over $3 billion last year as it strives to reach a total of $6 billion in cost reductions.
As a result, its net-debt-to-EBITDA ratio stood at 3.22 at the end of the fourth quarter. AT&T is targeting that to drop to 2.5 by the end of 2023.
Since AT&T's turnaround is in progress, investors won't truly know how the company will perform until after the WarnerMedia separation in the second quarter. The company's third-quarter earnings results will be a first look at the new AT&T's performance.
In the meantime, it's worth waiting to buy shares. If you already own shares, hold on to them. AT&T looks like it's on the right track to be a worthwhile telecom stock to invest in again in the future. It just needs to prove it can continue to replicate its 2021 successes first.
